Nov 23, 2023

What are Stablecoins and the Type of Stablecoins

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Stablecoins are digital assets issued on the blockchain that represent an equivalent value of a real-world asset, often a fiat currency like the U.S. dollar or Euro. Analogous to poker chips in a casino, they simplify transactions within the blockchain ecosystem, allowing for efficient and secure trades. These coins maintain their value based on the underlying asset they're pegged to, and users can exchange them back for real-world currency when desired. The trust in stablecoins is rooted in the belief that they can be redeemed for their corresponding asset. While most stablecoins are backed by reserves of the asset they represent, some algorithmic stablecoins, like the now-defunct UST (Terra) backed by Luna (now Luna Classic), tried to achieve stability through supply and demand mechanisms, aiming to decentralize reserve management.

As of July 26, 2023, the total market capitalization of Stablecoins is $126B. USDT by Tether dominates the market with a 66% share, followed by USDC by Circle at 21%. Some folks like Jesse Austin Campbell, an expert from Columbia Business School already equate the M2 money supply (valued at $22.8 trillion) to "U.S. dollar stablecoins". This supply includes $17.9 trillion in bank deposits and $4.8 trillion in money market funds. The primary distinction is that stablecoins operate on a 24/7 transparent public ledger, unlike bank deposits or DTCC-held shares.

Fiat-collateralized Stablecoins are pegged to real-world assets like the US Dollar or Euro. Examples include USDT, USDC, BUSD, and EURC. They're centralized, with entities like Circle for USDC and the Tether Foundation for USDT issuing them. A major concern is the transparency of their reserves. These stablecoins rely on the conventional financial system, given the need for bank accounts.

Crypto-collateralized Stablecoins were created to address the limitations of fiat-collateralized ones. They're backed by other cryptocurrencies or tokenized real-world assets. Due to cryptocurrency volatility, they're often over-collateralized. DAI is an example, soft-pegged to the USD. They are decentralized, minted by smart contracts. However, decision-making in their governing DAOs can be slow. Overcollateralization makes them less capital efficient. Some, like FRAX, even use centralized stablecoins as partial collateral, which has its own risks. This area is rapidly evolving with different strategies.

Algorithmic Stablecoins maintain value through algorithms rather than asset reserves. Some adjust their supply based on demand to maintain a steady price. They often use a two-token system, the Seigniorage Model. UST (Terra-LUNA) is a notable example. These stablecoins can offer arbitrage opportunities when prices deviate from their intended peg. They're still experimental; their stability depends on the algorithm's effectiveness and market trust. Terra (UST) notably collapsed in May 2022, raising concerns about the viability of such stablecoins.

Read more about stablecoins and their remittance use case in our latest research report Stablecoin Landscape and the Remittance Use Case co-authored by The Hedera Network, Myna, UnoCoin, Glo Dollar, Brale and Ethereum Enterprise Alliance.

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